I'm a freelance writer who has published in the New York Times, The Wall Street Journal, The Los Angeles Times and others, and the author of the Forbes ebook "The Millennial Game Plan: Career And Money Secrets To Succeed In Today’s World." I graduated Phi Beta Kappa with Honors from Stanford University and have a master of arts from Columbia University’s School of Journalism. To learn more about me, go to www.laurashin.com, or follow me at @laurashin.

Why Gen X And Late Boomers Aren't On Track For Retirement

According to a recent study, Gen X and late baby boomers are on track to replace only about half of their current income when they reach retirement — which means they’ll need to seriously downgrade their lifestyles. Most financial planners recommend replacing, at the very least, 70% of one’s income.

In contrast, Depression babies, War babies and early boomers were on track to replace, respectively, 86%, 99% and 82% of their pre-retirement income.

Why are more recent generations finding it harder to save enough for retirement?

I talked with two economics professors who cite two types of factors — the breakdown in the employer-provided retirement benefits and a wider web of increased debt and lack of financial literacy. Unfortunately, neither explanation offers a quick-fix solution, though they do hint at ways you can help improve your retirement picture.

Teresa Ghilarducci, a labor economist at the New School and a nationally recognized expert in retirement security, says there’s only one explanation for why Gen X and late baby boomers will be less ready for retirement than their parents were.

“The reason for the lack of preparedness is because of the collapse of one layer of the retirement cake, which is the employer-provided layer,” she said by phone.

In the last three decades, the number of unions fell, older workers faced higher unemployment and competition began to heat up with countries like China, making it harder for older workers to negotiate for stronger retirement benefits.

Additionally, as 401(k)s were being introduced in the 1980s, people thought they preferred to have control over their retirement accounts and their investments, said Ghilarducci. But it turns out that if they actually have a choice between a pension and a 401(k), they prefer the pension.

A pension is a type of “defined-benefit” account, giving an employee a lifetime payout based on a formula taking into account factors such as how long he or she has been with a company and not necessarily based on how well the investments do. A “defined-contribution” plan, such as a 401(k), on the other hand, offers no guarantee on how much money will eventually be paid out.

“When people have a choice — and they have a choice in the public sector — they actually choose, when they’re asked, for a defined-benefit plan. So, it’s clearly employers who prefer the 401(k), and that’s because they’re cheaper,” Ghilarducci said. (Companies that offer pensions have to dip into their own earnings if the pension’s investments fall short, since the employee will still receive the promised payout.)

Why Defined-Benefit Plans Are Better For Workers

According to Ghilarducci, there are four reasons that, for workers, defined-benefit plans such as pensions are superior to 401(k)s and similar accounts:

A defined-benefit plan requires the employee to enroll, unlike defined-contribution plans, which are often voluntary.

With such a plan, neither the employee nor his or her relatives can get access to their retirement savings. (This is a big drain on assets in defined-contribution plans such as 401(k) accounts.)

Defined-benefit plans offer a higher rate of return. “Professionals invest the defined-benefit plan,” Ghilarducci said, “not the individuals choosing various mutual funds. And defined-benefit plans always outperform defined-contribution plans.” In fact, last week, a study by Towers Watson showed that, in 2011, investment returns in pension plans outperformed those of defined-contribution plans by the largest margin since the 1990s. Out of 2,000 plan sponsors analyzed, defined-benefit plans had median investment returns of 2.74%, while defined-contribution plans had median returns of −0.22%.

Finally, a defined-benefit plan pays out an annuity for the rest of the employee’s life, so the employee doesn’t bear the risk of outliving his or her money — a frightening possibility for holders of 401(k)s and similar accounts.

Ghilarducci discounts some other factors that are frequently cited: “There’s a lot of noise that you’ll hear — that it’s lack of financial literacy, that it’s student debt,” she said. “None of those matter. Having an $8,000 or a $20,000 to $30,000 debt does not affect accumulating the more than $600,000 that most people need for retirement. Those are fly-speck reasons. There are lots more reasons to think that people are more financial literate now than they were 30 years ago. So no other reason holds a candle to the collapse of the employer-employee retirement system.”

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There’s also the little detail that us ordinary people have absolutely no trust in the financial system. Why should I trust my nest egg to some kind Wall Street employee to steal, or at least to make his bonuses by selling me garbage?

After the last several years, it is understandable that many people have lost trust in the financial system. However, there are ways to still make smart financial/investment decisions:

1. Look for low-fee investments, such low or no-cost ETFs or index funds, rather than active managed funds that may not produce better returns.

2. You can look for a financial advisor that is a fiduciary, meaning that he or she has taken an oath to always act in your best interest. These types of financial advisors aren’t the kind who make money off selling you particular investments. (You can read more in the related story up above, 10 Questions to Ask When Choosing a Financial Advisor: http://www.forbes.com/sites/laurashin/2013/05/09/10-questions-to-ask-when-choosing-a-financial-advisor/)

There two other important reasons other than those posited by Ms. Ghirarducci: asset prices and payroll taxes.

When Silent and early cohort Boomers began investing, asset prices were very low in relation to the amount of income those investments threw off. If you were investing in stocks or real estate, you had assets that could produce strong, rising cashflows in the form of dividends and rents (income producing real estate), or you could benefit from having a low house price (relative to your income) and enjoy rapidly rising wages (driven by inflation). You then have had a 30 year opportunity to refinance your mortgage at lower rates, and experience falling real housing costs over time.

Late Boomers and Xers didn’t get to start buying assets in significant amounts until after the 1980s phase of asset price increases had already raised prices significantly. 1970s cohorts of Xers started investing during the dotcom bubble. Where Boomers and Silents could load up on stocks with P/Es in the single digits between 1978-1983, Xers have faced stock P/Es above 20 for most of their investing lives, and sometimes over 40! Given the high prices (and low income) that Xers face, they have to save a far greater amount (read: higher percentage of income) than previous generations to generate the same level of income.

The other factor is taxes. GI and Silent generations have handed themselves massive benefits in the form of Social Security and Medicare for which they truly didn’t pay. GI generation beneficiaries paid no Medicare tax into their 40′s and 50′s, since the program did not exist. Even when they did start paying, they enforced a cap on the amount of income that was taxable. This was significant, since GIs were at their peak earnings at the time. Xers, by contrast, have been saddled with this 3% of income since the day they started working. If instead of paying Medicare premiums for freeloading GIs, Xers were able to dedicate 3% of their gross income to savings, as GIs could, Xers would have much better retirement prospects.

Social Security is similar. GIs and Silents went to work when Social Security taxes were 4 and 6%. Xers pay 12.4%. If SS taxes were 6% and Xers could save that 6% and 2.9% for Medicare, they would save nearly 10% of income: a figure most financial planners believe is a level of savings adequate to achieve 80% or more of pre-retirement income. Note that under such a regime, Xers would not have to sacrifice current consumption at all.

These factors, far more than the investment vehicle, drive relative performance.

Thanks for your great analysis, particularly the part about how the stock and housing markets rose in the 1980s and 1990s as opposed to more recent years. Just to be clear, though, many Gen Xers were not automatically enrolled in their 401(k)s when they began working, and so also were not saving for retirement at all unless they opted in. If they’d had pensions or any other kind of retirement account in which they were automatically enrolled, they would have at least had started invested in their early working years and would have reaped the rewards of some investments, even if the market was not doing as well.

True, Xers have had much less recourse to traditional pensions, which has meant that sensitivity to the power of compounding and starting early with savings has been important for Xers. (It isn’t impossible to find pensions, however, I am an Xer – Cohort 1974 – and when I was an employee, I was fortunate enough to have both a traditional pension and a 401(k) which was generously matched and I worked in the private sector. “Social democratic” Europe, where I live now, is actually much weaker on pensions than the US).

HOWEVER – one of the key reasons that traditional pensions have gone by the wayside is exactly the same issue: high asset prices and related low returns make it much more expensive to offer someone $1 of future income. Since pension accounting is incredibly sensitive to discount rates (which have been falling along with interest rates), present values of pension plans have skyrocketed. (An illustration: if you can expect to compound at 8% – not unreasonable if long-term bonds are yielding 6.5-7% – then over a 36 year investment horizon, you will have 4 doublings of your initial investment, which means you only need to put away 1/16 of the future $1, or 6.25 cents. If however, you compound at 6% – maybe possible with long bond yields below 4% – then you have only 3 doublings and you need to put away 12.5 cents: the employer cost of the benefit has doubled! Lower rates only make the problem worse. At 4% expected return, there are only 2 doublings, and the employer has to pay 25 cents).

Given the increasing cost of funding the same benefit – and the very long term one-way direction of lower rates, and higher employer costs, it is not surprising that they have asked whether the benefit is affordable, and have considered alternatives that make costs more predictable and less sensitive to interest rates. Employers might have cut costs elsewhere – e.g. substituting labor for capital – but that might also have been tough on Xers and late Boomers.

Moreover, the same Silent and GIs who stole Xer retirements with Social Security, did the same by constantly pushing for higher payouts for themselves in the 1960s and 1970s (moaning about “fixed incomes”). Increasing pension pots increased interest rate sensitivity and volatility in earnings, even for non-financial companies. Had they been smaller, corporate managements would have had much less incentive to eliminate them.

It hasn’t been all risk management, either. Firms have had to look at their suite of employee compensation (wages, pensions and benefits) and decide what allocation attracted the best talent. Since pensions were becoming very expensive, there was a growing wage differential – note that public sector employees usually moan about how little their starting salaries are, but this is due in no small part to the value of their pensions – unlike the government, if you need talent rather than functionaries, you have to be worried that lower starting salaries will see you lose out to the competition.

But here again GIs and Silents have contributed mightily to medical inflation and the related insurance premiums, which have risen steadily and are a major limitation on Xer wages. If the costs of benefits and pensions rise faster than productivity, then either wages have to grow slower to keep total comp in line with output, hours worked have to increase to increase output above that which productivity allows, or returns to capital have to fall; or all three).

The biggest thing I want to stress is that late Boomer and Xer preparedness for retirement is NOT a reflection of a lack of virtue, as it is often portrayed. The normal view is that somehow Xers are too dumb, clueless or tuned out to “do the right thing” and that earlier generations relatively higher wealth is a reflection of their virtue by comparison. This is a fallacy that assumes that Xers had similar choices – they haven’t. The different (and qualitatively less good) options Xers have had are not the “fault” of employers, either. They are driven to a surprising extent by investors willingness to pay high prices for income streams.

I don’t know too many people advocating or cheering lower stock prices or lower house prices. But then I also don’t know people who cheer when the price of hamburgers and milk rise. Personally, I like it when assets can be purchased cheaply, whether they are financial or consumables. I think it is silly (if understandable) that politicians want incompatible things: high and rising house prices and affordable housing. I find it sad (though also unsurprising) that governments have turned to easy financing in an effort to square the circle, with the inevitable effects.

Xers have some hope – the secular bear will end sometime between 2018 and 2020, if the current cycle follows historical norms. After which, returns will be not too bad. Not unlike the person with a small nest egg in 1982, it will be possible to have assets be very, very productive, and to feed yourself with a much smaller (relative to income) nest egg than someone who retired in 1999 will have required.

Till then, I look to pick my stocks carefully. It is why I read Forbes.

I agree that pensions are not cheaper for companies, because they have to make up for any shortfalls in investment performance. But of course, what is good for them has been bad for their workers. I’m not an expert on European retirement systems but got the impression from this story (and talking to friends) that safety nets are better here: http://www.nytimes.com/2013/05/15/business/retirementspecial/international-retirement-plans-offer-insight-to-aid-americas-system.html?pagewanted=all&_r=0

And the only other thing I can say to your response is that maybe instead of reading Forbes, you should write for Forbes!

Thanks for the complement – I’m blushing. :) I’d love to write for Forbes. Seriously. If you have thoughts on how to go about this, please tell me.

You are right about the loss of the traditional pension – it has put employees at much greater risk – and few are really equipped even to understand, let alone to manage that risk. It may be that economically it is still better than the alternative (very low wages) but you might be right, it might have been better had people not had the option to take more risk. It certainly would have been better had the “asset management” industry not been able to market to all sorts of people that they would be much better off investing on their own account. Some will be, others will not be.

European systems are more “social” than American systems, which means, sadly, the lower-middle class gets the shaft in the end. But, benefits are so constructed that the same people who pay them, can’t imagine how they would live without the insurance (since they are basically prohibited by the very cost of the programs from building any meaningful personal savings).

In Germany, where I live, you have relatively high marginal tax rates (the 2nd highest bracket 42% is reached with 58,000€ – about $80k). On top of that, we have the “Solidarity Surtax” which was intended to fund rehabilitation of East Germany, but which has just become another slush fund. This is 5.5% of your income tax, so the real rate is 44.2%

On top of that, the social security system takes 19.9% of income up to 66,000€ and the univeral public health insurance takes another 15% or so up to €45k. (This includes the employer and employee portions).

Finally, when that is all done, you pay 19% on anything you buy. So net income is pretty low.

Note that the rate is higher, on a smaller bundle of income than in the US. Still, this is good for about 1400€ a month in pension. thing is, only about 40% of Germans own a home. So ALOT of that 1400€ goes to pay rent.

Now, the scandal in much of this is that the wealthy can largely escape these problems. Self employed “Free Professionals” – Consultants, Lawyers, Doctors, etc. are exempt from Social Security tax. Likewise anyone earning above the social insurance threshold (for health insurance) – the top 10% approximately – can opt into the private market where you get better benefits at less cost (because you are not subventing low-income folks). Your costs do rise with age in the private system, however.

Similarly, there are just oodles of deductions, so not unlike the US, you have all sorts of things that don’t count as tax.

The highly educated also don’t pay for their schooling, largely, since tuition is barebones. This means that working class people subsidize the very “Free Professionials” who then get a pass on the social insurance system. Moreover, like any VAT-heavy system, the biggest single revenue generator is incredibly regressive. If you CAN save, you can really avoid alot of tax.

Finally, things that might discourage inherited wealth (and put more emphasis on making your own way) – namely Inheritance Tax, is incredibly low in Germany. With about a 25% rate, depending on the relationship to the person passing you the assets (there is a higher rate on inheritance from grandma than from your parents, which I guess is intended to discourage generation skipping).

Mostly, I think this is a result of opposing capital formation among the middle class. If you can’t form much new capital, you have to protect and grow the capital you have (in the hands of the already well-off) and try and ensure good rates of return on it (lest it flee to other markets).

It’s a personal thing – but I think the sign of a good social system is not how universally required it is, but how well it makes itself unnecessary, but encouraging policies that enable the populace to manage their own affairs. On this scale, Europe fails miserably. Yes, benefit entitlements as a share of your income are HIGHER, this is not necessarily BETTER, since ultimately, you have to “do it the regulators’ way” to qualify. It is a formula for avoiding idiosyncratic risk (that you do worse than your neighbor), but at the price of low systemic dynamism.

Thanks again for the conversation – it is a really, really important topic and I hope you will stay on it.

I used to save 75% of my paycheck and now even after couple loans I took, I save 50% of my salary…so yes people do save. But I DO NOT trust 401k, IRA, and any of these wall street financial systems with my money. And most of the average american have no trust in the financial system. And why should they? Why Forbes never tell the readers how 401k money is used by these firms to gamble and exponentially increase their own profits ?

Bravo to you for saving so much. Another commenter said something similar about not trusting the financial system. I plan to do another post on what to look out for when choosing your investments, but I also thought I’d respond to you with the tips I gave the other commenter above: 1. Look for low-fee investments, such low or no-cost ETFs or index funds, rather than actively managed funds that may not produce better returns.

2. You can look for a financial advisor that is a fiduciary, meaning that he or she has taken an oath to always act in your best interest. These types of financial advisors aren’t the kind who make money off selling you particular investments. (You can read more in the related story up above, 10 Questions to Ask When Choosing a Financial Advisor: http://www.forbes.com/sites/laurashin/2013/05/09/10-questions-to-ask-when-choosing-a-financial-advisor/)